Sinead Rafferty, Portfolio Specialist, MLC provides valuable insights into the effect volatile markets may have on retirement income streams. The original article can be sourced here.
How have account based pensions performed after previous market corrections?
An account based pension is an investment that you can begin using superannuation money once you meet certain conditions. It provides a regular, tax-effective income.
Chart 1 shows how an account based pension invested 70% in growth assets (shares and property securities) and 30% in defensive assets (fixed income and cash) would have performed if a retiree had started the pension during some key market downturns of the past. It assumes the retiree was aged 60 and had an account balance of $500,000 when they began their pension. It also assumes they drew down the minimum annual income payment each year.
Chart 1: Real annual pension incomes for selected start dates for an account based pension strategy with an asset allocation of 70% growth/30% defensive assets
Note: The portfolio consists of Australian shares (32%), global shares (hedged) (8%), global shares (unhedged) (24%), global property securities (6%), Australian fixed income (10%), global fixed income (10%) and cash (10%).
The sudden jumps in incomes at ages 70 and 80 are due to the rising minimum incomes investors are required to draw from account based pensions as their age increases.
Returns are based on investment market returns from 1900 to 2017 (before fees and tax). Historical returns aren’t a reliable indicator of future investment returns.
Source: Calculations by NAB Asset Management Services Limited and investment market data from Global Financial Data, Inc. and FactSet.Chart 1 shows the annual pension payments in today’s dollars (we’ve adjusted for inflation) for an account based pension that started in four different years:
- The 2008 global financial crisis. While the initial result was particularly poor, the income levels have now recovered to pre-crisis levels.
- 1981, when the market slumped on concerns about the health of the US economy. Despite a further slump with the bursting of the dot com bubble in 2000, those who began their pension in 1981 fared well overall.
- 1973, during a period of very high inflation. While there was an initial decline, for those who maintained their investment strategy the outcome was ultimately strong as the very positive markets of the 1980s offset the 1970s.
- The start of 1929, during the Great Depression. While the pension initially performed poorly, 1932 and 1933 delivered very strong returns and the pension stream improved. Incomes suffered as a result of the share market fall in 1952, during the Korean War, but despite all these events, the outcome improved for those who remained invested.
There are important lessons in this look at history. During retirement, you should expect financial markets to deliver a wide variety of returns and at times, returns will be disappointing – as they were over the 2018 calendar year. Both positive and negative periods can continue for some time. Over time, markets generally do recover from serious downturns, but the very strong market returns that we’ve seen over the last decade are abnormally high.
If your time horizon is long enough, the higher return potential of shares usually does come through. But this can take a long time − you’ll need to be patient, and focus on how you’re progressing towards your longer-term financial goals, rather than on the frequent ups and downs of the market.
What if you switch to a more conservative startegy after a major market fall?
History teaches us another important lesson about reacting to market volatility. Assuming you’re in the right investment strategy to start with, switching to a more conservative strategy after a significant market fall probably won’t be in your best interests. Adopting this approach is likely to impact your lifestyle in retirement.
Chart 2 shows the impact on a pension income of switching from a 70% growth assets strategy to a 30% growth assets strategy after some of the worst one-year returns in history. It shows how much less you’d receive if you changed to the more conservative strategy.
Chart 2: Impact on pension payments of switching to a lower risk investment strategy after a major market fall
Note: This chart shows the impact of moving from a portfolio with the asset allocation in Chart 1 to a portfolio consisting of Australian shares (12%), global shares (hedged) (1%), global shares (unhedged) (13%), global property securities (4%), Australian fixed income (30%), global fixed income (30%) and cash (10%).
The sudden jumps in incomes at ages 70 and 80 are due to the rising minimum incomes investors are required to draw from account based pensions as their age increases.
Historical returns aren’t a reliable indicator of future investment returns.
Source: Calculations by NAB Asset Management Services Limited and investment market data from Global Financial Data, Inc. and FactSet.
While in some cases switching to lower risk investments resulted in a short-term increase in the income the investor received, it was generally a losing strategy because it was difficult for the portfolio to recover from the significant negative returns. This could mean that an investor is drawing down more on their capital than they anticipated, so their retirement funds could run out too soon.
Conclusion
In planning a retirement strategy, it’s important to take into account both that negative market events could happen and that over time, markets generally recover from these. If you expect this, you’ll be more able to resist the temptation to sell out of the market, or move into a more conservative strategy, when a market slump occurs. By maintaining your investment strategy at these times, you’ll be well positioned to benefit when the market recovery happens.
mportant information
This publication is provided by MLC Investments Limited (ABN 30 002 641 661, AFSL 230705) (MLCI) a member of the group of companies comprised National Australia Bank Limited (ABN 12 004 044 937, AFSL 230686), its related companies, associated entities and any officer, employee, agent, adviser or contractor therefore (‘NAB Group’). Any references to “we” include members of the NAB Group. An investment with MLC does not represent a deposit or liability of, and is not guaranteed by, NAB or any other member of the NAB Group. NAB does not guarantee or otherwise accept any liability in respect of any financial product referred to in this document. This information may constitute general advice. It has been prepared without taking account of an investor’s objectives, financial situation or needs and because of that an investor should, before acting on the advice, consider the appropriateness of the advice having regard to their personal objectives, financial situation and needs. Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market. Returns are not guaranteed and actual returns may vary from any target returns described in this document. No representations are made that they will be met. Please note that all performance reported is before management fees and taxes, unless otherwise stated. Opinions constitute our judgment at the time of issue and are subject to change. We believe that the information contained in this publication is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made at the time of compilation. MLC may use the services of NAB Group companies where it makes good business sense to do so and will benefit customers. Amounts paid for these services are always negotiated on an arm’s length basis. |
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